MONOPOLISTIC COMPETITION

Meaning

Monopolistic competition is a
combination of both ‘monopoly’ and ‘competition’ The credit of developing this
theory goes to Prof. Edward Hastings Chamberlain of Harward University. He is
the main architect and builder of this theory. In reality there is no monopoly
and perfect competition and there exists only monopolistic competition.

Main Features

Monopolistic competition is
characterized by the existence of several firms selling goods which are close
substitutes of each other. The following are the important features of
monopolistic competition

.

1. Existence of a large number of firms

There are a large number of firms
producing goods under monopolistic competition. It may vary from ten to thirty,
as the number of firms is quite large.

2. Product Differentiation

The most important feature of
monopolistic competition is product differentiation. The products are identical
but not similar. For example, different manufactures produce soaps under
different brands like Lux, Hamam, Pears, Lyril and so on. Product
differentiation can be brought about through differences in branding, trade
mark, package, design and colour.

3. Selling Costs

Another feature of monopolistic
competition is selling costs. The firm under monopolistic competition should
incur certain expenditure on promoting the sales. The amount spent by the firm
on sales promotion is known as selling costs. Selling costs include not only
the advertising costs but also other costs such as salaries of salesman, door
to door canvassing etc.

4. Free entry and exist

There is a freedom of entry and
exist of firms. A new firm may enter into the production and an old firm may
come out of the production.

5. Group of firms

In monopolistic competition, the term
“Group Equilibrium” is used to denote the number of firms producing similar
goods

Price Determination under
Monopolistic Competition:

Short-run Equilibrium

Under monopolistic competition,
different firms produce different varieties of products. Each firm will fix its
own output and price. Like any other firm, the firms under monopolistic
competition attempts to maximize the profits. The firm under monopolistic
competition in the short-run will be in equilibrium when MC = MR. The price and
output determination are shown with the help of the following diagram.

In the diagram-

AC is the average cost curve.

MC is the marginal cost curve.

AR is the average revenue curve.

MR is the marginal revenue curve.

At point K equilibrium is
established, where MC – MR. The equilibrium output is OM. MR is the cost and MQ
is the price, the firm earns super normal profits which are shown by the shaded
area PQRS.

Equilibrium with Losses

When average revenue is less than
the average cost the firm may incur loss. This is shown in the following
diagram

Q is the equilibrium with MR – MC.

PQRS-Total Loss.

Long-run Equilibrium or Group Equilibrium
under Monopolistic Competition

According to Prof. Chamberlin, a
group consists of many firms whose products are very much similar to one
another. A ‘Group’ is not one industry. The term ‘industry’ is much broader
than the term ‘group’. An industry may consist of many groups of Producers. For
example, in the soap industry, one group may specialize in toilet soap another
group may produce shaving soap. There will be a competition between the firms
in the same group but not between different groups.

In order to present the group
equilibrium, Prof. Chamberlin makes certain assumptions. The important
assumption is that each firm has identical demand. This assumption is called
the “Symmetry” or “Heroic” assumption. The equilibrium of group under
monopolistic competition may be shown with the help of the following diagram.

The
long-run group equilibrium is established at the point where AC- Price. This is
possible only when the AC is tangent to the AR. In this figure AR is tangent to
AC curve at point Q. The equilibrium output is OM
and the price is OP which is equal to the cost of production. At this price,
the firms in the group are earning only normal profits and supernormal profits
have disappeared. All the firm in the group are also in equilibrium. This is
called ‘Group Equilibrium’.

Selling Costs

The firm under monopolistic
competition incurs certain expenditure on selling activities. This is called
selling cost. These objective of the selling costs is to increase the demand
for the products of he firm. Prof. Chamberlin has defined selling costs as
costs incurred in order to alter the position and shape of a demand curve for a
product.More NotesRelated Topics